Calendar Collars

Discussion in 'Options' started by jones247, Dec 26, 2009.

  1. Assuming that we all understand the potential benefits of a calendar collar, I'll like to focus on the potential problems/challenges of this strategy and the best ways to overcome them...

    Two major challenges: (1) the theta impact on the front month long option; (2) the adverse impact of a rise in implied volatility.

    There may be other challenges; however, because this strategy is negative theta and vega, I'm trying to determine the best ways to adjust my positions when the Greeks are going against me.

  2. Dear Walt,
    I very much enjoy discussing strategies with you. Our Double Broken Butterfly discussion was very interesting and it is one of the best strategies to trade, especially in a slowly trending market like we have now.
  3. Sorry, I accidentally hit the post button before I finished my comments.

    Continuing, I think the calendar collar idea is an interesting one. It really relies on the fact that you're hedged both ways, but up on cash, hoping for some movement to help you out to either profit within the month on a price decline or get cheap puts in the event of a significant upward move .

    You are correct to identify an IV increase as a major threat, but you should consider this. If you hold the stock and write a two or three month call against it, IV is only likely to increase dramatically if the stock plummets in value (check out the caveat relating to earnings for one major exception). In that event, the put will increase in value matching the decline in the stock (we're talking at expiry to keep the calculations more straightforward). The stock (S) plus the put (P) will equal the strike price of the put. The call written against the stock will decrease in value, but the exact amount of the decline is unknown at the time of entry. What will be clear is that if S declines a lot, the call will also decline noticeably because of the negative deltas. This means that you could buy it back for much less than you paid for it. Overall, a significant decline in S will yield a modest profit. You will want to exit at the expiry of the puts and take your profits then. Buying a second put for much more than the first put cost leaves you in trouble.

    What really hurts calendar collars is having the S stay in a very narrow range. Then when it comes time to buy the second put, it will cost as much as the first put, leaving you with no benefit compared to a standard collar, and most times modestly worse off since two month calls are usually not worth twice as much as one month calls.

    If the S rises, the second month put, written at the original strike will likely be cheaper, as the IV will possibly contract a little and you are not ATM anymore. If S rises quite a bit, you might want to take a flyer and buy the put one or two strikes higher than you originally bought the stock at, but making sure that you don't pay as much in total for the puts as the call originally sold for. Then if S falls, you can make a little windfall on a decrease.

    You probably also want to avoid stock where the IV is or likely will be rising because of earnings coming out in the next month. This will add unnecessary complications to your position, and some additional risks. Typically the longer dated options rise less than the front month options in this type of scenario as people play these for quick gains (or losses), but if you are stuck buying a put for twice as much as the original put cost at the front month expiry, and S is the same as it was on the entry date, you have a loser on your hands. The call will be likely be worth a substantial fraction of its original price with this IV rise, leaving you with no gain on the stock, a dead loss on the first put, and only a tiny gain on the call, if any. This of course is a worst case scenario, and it will lead to about a maximum 5% loss on the position. If you are comfortable with that, then by all means, go ahead. Remember, however, that the maximum possible gains are also limited by the written call.

    This position succeeds with major gains or losses in S, and can be a big winner if the stock rises a lot, and then falls a lot in the second month.
  4. Thanks John,

    Likewise, I also appreciate your contributions. Despite the benefits of the Double Broken Wing Butterfly, I truly believe that the Calendar Collar (CC) has a better risk/reward profile...

    Ragarding the CC, I believe that the theta challenge is the bigger problem, as the Vega challenge is easier to manage.

    If I'm unable to manage these challenges, then I'll simply focus only on regular collars.

  5. spindr0


    While your premature ejection of your reply seemed a bit incongruous, it was timely for me since I've been meaning to post a request for suggestions of high probability/low profit strategies for lower risk money. But since I don't want to hijack the thread, I'll search for and bump the DBB thread.
  6. spindr0


  7. Hey John,

    I'd like to bounce the following adjustment to the calendar collar off you:

    Instead of buying a front month put (30 days from expiration) and selling a 60 day call, I would move all transactions an additional 30 days out. In other words, buy a 60 day put and sell a 90 day call. The plan would be to make the adjustment (i.e. roll) or close-out the collar within 30 days after establishing the position. The theta impact is most aggressive in the last 30 days. Therefore, I would aim to never have a long position with less than 30 days to expiration.

    If I needed to make an adjustment/roll, I believe that I could close-out the call & put after 30 days, then open a new 60 day long put and a new 90 day long call. I'm testing the prospects of the new positions being twice as much as the inital position. In other words, if I began with 1 option contract, then at the first roll I would enter 2 option contracts, and at the 3rd roll (if necessary), I would enter 3 option contracts. Once I'm profitable, then I'll reset my positions to 1 option contract.

    Btw, a MAJOR enhancement that I'm VERY hesitant to share is a mechanism for using leverage to multiply the return on capital.

  8. Hey Spindr0,

    Thanks for your feedback; however, I believe that a short strangle with long ratio wings or a backspread has a better risk:reward and win rate than the DBWB... but that's another thread...

  9. Spin and Walt,
    Looks like a really good discussion shaping up!
    A few more comments--
    1) Don't write off the double broken butterfly. Just last month, I set up some that involved a potential reward roughly equivalent to the margin committed, but with a win rate exceeding 75% (of course, the win amount would be low much of the time). With adjustments available and careful management, I think that the win rate can actually reach close to 90% and the reward can also be increased. The market has been cooperating nicely so far. If things keep going well, I'll have to have you two up to Alberta for some of the best steak you'll find anywhere to help me celebrate! I don't think collars can give that kind of profitability unless very actively managed as described at the end of this post, frankly. Most of the time, the risk is very small, but the reward is modest at best, being limited by the written calls.

    2) Just to be very specific and make sure we are all on the exact same page, I define a calendar collar as
    a) buy 100 shares of stock (you could use margin, but this increases risk).
    b) sell 1 call ATM or one strike above. This call is two or three months in duration.
    c) buy 1 put ATM or one strike below expiring in the current month.
    Walt is also proposing a variation that has a 3 month call and a 2 month put, which also qualifies, although less risky than the one we've been talking about.
    Ideally, these positions are put on when a stock is right on a particular strike price which makes matters simpler.
    You can skew things according to your own bias on the direction of the stock, but this can change the structure of returns quite a bit. Most people start out with no assumption of direction and then try to manage them for a profit. In that case, setting up on a strike avoids bias.

    c) Now to the theta decay issue. There is no easy way to avoid decay. As you no doubt know, the rate of decay is fastest in the front month. In fact, in most real life situations, for a call or put that expires in two months, 60-75% of the decay will be in the last four weeks, and only 25-40% of the decay will happen in the first four weeks. If, for example, you move to the 2 vs. 3 month situation Walt mentions, your decay ratio (put decay versus call decay) is better, but you will still want some movement to help your position. Obviously, if the stock moves upward somewhat, the next puts will be cheaper. If the market moves downward, the position will need to be exited. The no movement situation is the most uncertain of the three.

    d) Spin-- I believe that if the stock moves sharply downward (at least 15-20%) by the end of the first month, the value of the written call will decline pretty dramatically. It will have some theta decay, and the deltas also will help quite a bit, more than likely offsetting the vega issues. At the point of expiry, the put + the stock will be equal to the ATM strike meaning their total value is fixed in the event of a decline. So I contend that this is a way to modest profits if exited at the front month expiry. If the call declines enough so that it decreases more than the cost of the put, you will earn a little, perhaps 2-3%.

    e) I have seen some Optionetics discussions about active management of these types of positions, rolling puts and calls to different strikes as conditions dictate, using some specific rules to help guide the decision making process. These might be helpful in many situations. Many of them operate in a similar manner to the adjustment I described in my first post, where a sharp rise resulted in rolling the puts up a couple of strikes, hoping to have a retreat soon after so that some noticeable profits could be made. A sudden drop could also be used in a similar way, rolling the calls to lower strikes and hoping for a rebound. A stock that behaved in a jagged pattern would be superb for this strategy. At first glance, this is the one way that I can see collars being used to generate profits that could exceed 10% in a month. Any other ideas??
  10. I keep having additional thoughts on this issue! One thing I forget to mention with these is that it may be desirable to keep rolling back for credits, but for most stocks some months are not available. For instance, I looked at Apple as a candidate for this strategy. Right now March is not yet available to roll to, but April is. March will eventually become available, but it may not be there when you need it to be. As a result, you may not always be able to choose exactly which month you are working with. My guess is that working four months out is generally not that great an alternative because the theta decay ratio will become even more unpleasant while generating very little extra cash and dramatically increasing the risks.
    #10     Dec 26, 2009